Doctrine of Capital Maintenance

The mere expression 'net ASSETS' tells us that there are (in theory, at least) sufficient assets to satisfy creditors' claims. Problems arise when liabilities exceed assets and we have a 'net liabilities' situation You say that you are looking forward to an early reply. A reply is, by definition, a response to a question. And yet I see no question in your post ??? Do you have a question now or is my observation sufficient to resolve your doubts?

Thankyou Tutor, based upon your last response does this means that Capital Maintenance is more a theoretical concept than having more practical relevance? In regards to example of XYZ Corp. What i want to ask is that Net Asset (Asset - Liability) is $1500,000. What does the figure $1500,000 signify to the creditor ? How by this figure they feel that their debt is secured? Is it because that the Amount of $1500,000 theoretically shows that even if the company were to incur losses up to $1,500,000, there would still be sufficient assets to cover the claims of Creditors? In a different sense can we say that if the company were to liquidate its assets at their stated values in the Statement of Financial Position (SOFP), there would still be an excess of $1,500,000 after paying off the debts. Thus, the excess serves as a cushion for creditors, giving them confidence that their debts are safe .

Consider this statement of financial position: Share capital 1,000 Share premium 100 Retained earnings 1,200 Total shareholders' funds 2,300 Assets 2,800 Liabilities 500 Net assets 2.300 (As per John's lectures in the early accounting paper, shareholders' funds = net assets) Our company wishes to pay a dividend out of profits available for the purpose. In our case, that's 1,200 (accumulated realised profits less accumulated realised losses) Dividend of 300 Statement of financial position is now: Share capital 1,000 Share premium 100 Retained earnings 900 Shareholders' funds 2,000 Assets 2,500 Liabilities 500 Net assets 2,000 Even if our company were to make a loss next year, say 700, the statement would then read: Share capital 1,000 Share premium 100 Retained earnings 200 Shareholders' funds 1,300 Assets 1,800 Liabilities 500 Net assets 1,300 Let's convert the share premium into shares Share capital 1,100 Share premium nil Retained earnings 200 Shareholders' funds 1,300 Assets 1,800 Liabilities 500 Net assets 1,300 Still ample coverage of the 500 payables. In fact, that share capital figure (together with any undistributable reserves like the share premium account) is collectively referred to as the 'creditors' buffer fund'. It's the amount below which the net assets cannot fall ... IN THEORY Next year, we sustain a loss. 900! Revised statement is now: Share capital 1,100 Retained earnings (700) Shareholders' funds 400 Assets 900 Liabilities 500 Net assets 400 Can we now pay a dividend? No, not without breaking the capital maintenance rules. Say we wanted to pay a dividend of 600 to our troubled shareholders (we can't! But pretend we can) Share capital 1,100 Retained earnings (1,300) Shareholders' funds (200) Assets 300 Liabilities 500 Net liabilities (200) Now what chance do our payables have of getting their balance repaid? But notice that the share capital figure still stands at 1,100! This was the major element of the creditors' buffer fund. And yet the payables now have no chance to recover their balance. So the concept of capital maintenance is all well and good ... but you cannot legislate against companies making losses! Instead of a dividend in that last illustration, say our company makes another devastating loss. Say 600 Now we have: Share capital 1,100 Retained earnings (1,300) Shareholders' funds (200) Assets 300 Liabilities 500 Net liabilities (200) Your posts appear to me to be comparing the payables figure with the share capital amount. That would not be a sensible approach OK?